FRC raises the bar for risk management

PN 094

06 Nov 2013

The Financial Reporting Council (FRC) has today published for consultation changes to the UK Corporate Governance Code, guidance for boards of listed companies and standards for auditors covering risk management and reporting. Supplementary guidance for directors of all banks is also being issued.

The proposals build on the FRC’s work on “Boards and risk” and aim to raise the bar for risk management by boards and communication to the providers of risk capital about the risks faced by companies in which they invest and how they are managed or mitigated.

In response to concerns expressed on earlier proposals issued in January, these new proposals set out afresh how the FRC will implement the recommendations of Lord Sharman’s 2012 Inquiry ‘Going Concern and Liquidity Risks: Lessons for companies and auditors’. The Inquiry looked at the corporate governance and reporting lessons to be learnt from the failure of ostensibly healthy businesses in the financial crisis.

The FRC has made a key change in these proposals by bringing together its previous guidance on risk management and internal control with the assessment of the going concern basis of accounting; so encouraging the integrated assessment and reporting recommended by Lord Sharman.

Melanie McLaren, Executive Director, Codes and Standards, said:

“Risk management is one of the most important responsibilities of the board. Understanding the principal risks facing the company is essential for the development of strategic objectives, and the ability to seize new opportunities. For investors, as providers of risk capital, knowing how the board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that investors seek. The new guidance, and the proposed changes to the Code, highlight the issues that boards need to consider when assessing and managing risk, crucially including risks to solvency and liquidity. We have placed considerable emphasis on the need for robust assessment by boards and on the important role of auditors in ensuring reliable communication to investors.”

Broader Risk Considerations and Role of the Auditor

The draft guidance sets out boards’ responsibilities for setting the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organisation, and assessing and managing the principal risks facing the company, including risks to its solvency and liquidity. As now, boards should summarise the process applied in reviewing the effectiveness of the system of risk management and internal control. There is a new encouragement to explain what actions have been or are being taken to remedy any significant failings or weaknesses identified from that review.

Under the proposals, auditors will be required, in meeting their current requirement to consider whether reporting is fair, balanced and understandable, to consider and report if they are aware of any material matter in connection with the disclosure of principal risks that should be disclosed.

Solvency and Liquidity Risks and Going Concern

In response to the recommendations made by Lord Sharman the FRC proposes a new Corporate Governance Code provision and related guidance. They establish the need for a robust assessment by companies of how they manage or mitigate their principal risks, including risks to solvency and liquidity, and to explain which if any of those risks have also given rise to material uncertainties for the purposes of reporting on the company’s going concern basis of accounting. The FRC is, therefore, proposing to remove the current Code provision requiring listed companies to make a “going concern” statement. That statement is focussed on the narrow meaning of assessing the going concern basis of accounting, and so detracts from the broader integrated assessment and description of solvency and liquidity risks envisaged by Lord Sharman.

Banking considerations

The Sharman Inquiry also looked at whether a special disclosure regime is required for banks and concluded that this should not be necessary. The Inquiry considered it important that the FRC should clarify that a conclusion that a bank is or would be reliant, in stressed circumstances, on access to liquidity support from central banks that is reasonably assured, does not necessarily mean that the bank is not a going concern or that material uncertainty disclosures or an auditor’s emphasis of matter paragraph are required.

The FRC issued guidance for banks along those lines in January which found general support. Accordingly, the FRC is also now consulting on supplementary guidance to directors of banks updated only in respect of the proposed integrated guidance and developments in the regulatory regime.

Feedback Statement and Other Companies

A detailed feedback statement on the FRC’s January proposals is also being published today. Those proposals extended to unlisted entities other than banks and met with considerable adverse feedback. The FRC plans to consult in 2014 separately on draft guidance for directors of such companies and is currently considering the development of simpler and more proportionate guidance.

The consultation announced today closes on 24 January 2014. The FRC expects to issue the final Code, guidance and standards in the middle of 2014 with application for financial years beginning on or after 1 October 2014.

Notes to Editors

The FRC is responsible for promoting high quality corporate governance and reporting to foster investment. We set the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work. We represent UK interests in international standard-setting. We also monitor and take action to promote the quality of corporate reporting and auditing. We operate independent disciplinary arrangements for accountants and actuaries; and oversee the regulatory activities of the accountancy and actuarial professional bodies.

The primary purpose of assessment and reporting should be to reinforce responsible behaviour in the management of risks over the cycle, including solvency and liquidity risks, that would threaten the survival of the company; and that the FRC should:

Seek to clarify and harmonise the differing definitions of “going concern” and related risks in accounting, auditing and governance requirements

Review its Guidance for Directors to ensure that the related risk assessment is integrated with business planning and risk management

Integrate reporting of such risks with its wider proposals, to present a fuller picture of the principal risks the entity is taking and facing in pursuit of its business model and strategy rather than only highlighting solvency and liquidity risks when there are significant doubts about the entity’s survival.

Enhance the role of the auditor by seeking an explicit statement in the auditor’s report about whether the auditor has anything to add to or emphasise in relation to the narrative disclosures made by the directors about the robustness of the process of assessing solvency and liquidity risks and its outcome.

In January 2013 the FRC consulted on how best to implement Lord Sharman's proposals on going concern, published in 2012. It announced at the same time that it intended to consult on an updated version of ‘Internal Control: Guidance to Directors’ (often referred to as the “Turnbull Guidance”), which was last updated in 2005. The FRC has decided to bring together its guidance on these matters in one place to encourage boards, as part of the same broad on-going process, to consider risk identification and management, including the assessment of solvency and liquidity risks, and to determine whether the company is able to adopt the going concern basis of accounting. The draft guidance would replace ‘Internal Control: Guidance for Directors’ (2005) and ‘Going Concern and Liquidity Risk: Guidance for Directors’ (2009). Subject to consultation, the intention is to publish the revised guidance in the first half of 2014 to take effect simultaneously with proposed changes to the Code to apply to reporting periods beginning on or after 1 October 2014.